Small Business

IPOs: Are They DOA?

Venture-backed initial public offerings have been declining, and as VCs make more demands, entrepreneurs have been looking at alternatives

According to a recent report from the National Venture Capital Assn., the IPO market has been deteriorating (BusinessWeek.com, 7/1/08). For the first time since 1978, there were no VC-backed IPOs in the second quarter. And there were only five such deals in the first quarter. Another ominous sign: The median age of a VC-backed company from start to IPO was 8.6 years in 2007 (a 27-year high).

I recently talked to a venture capitalist about these shifts. He was glum and thought the slowdown was more than a temporary phenomenon. Indeed, he predicted we'd continue to see tepid IPO activity, at least for VC-backed IPOs. If he's right, this means entrepreneurs should rethink any plans to go public (BusinessWeek.com, 2/27/08).

There are many explanations for the current environment. With a 20% drop in the Dow-Jones industrial average and the Nasdaq since October, investors are skittish. The U.S. economy is beset with problems, from the credit crunch to high energy prices to slow growth. As Wall Street cuts costs, there will be fewer investment bankers to take companies public or analysts to cover them in the aftermarket. Another problem is the tough regulatory environment, especially the Sarbanes-Oxley Act.

VCs Will Expect More

Perhaps another reason: We haven't seen a disruptive new technology recently. For example, the Internet supercharged the IPO market in the 1990s, as the PC revolution did in the 1980s.

So amid the turmoil, it's a good bet venture capitalists will demand lower valuations and stronger deal terms. It's also likely it will take longer to raise capital. And don't expect to receive all the capital up front; rather, VCs will attempt to link capital infusions to various milestones.

Just look at FON, a fast-growing peer-to-peer broadband play. In April, the company raised $9.5 million. Sounds good, huh? Not necessarily. Founder and CEO Martin Varsavsky wrote a brutally honest blog post about it. He mentioned that current market conditions forced less spending. He wrote that his goal is to cut losses from $1.3 million a month to $500,000 by June of this year and reach breakeven by 2009.

I don't think this is an isolated case. To deal with the current environment, entrepreneurs have to find ways to increase revenues, keep costs low, and reach profitability faster. Strangely enough, success may be a matter of surviving, not thriving.

Quicker to Find a Partner

In fact, entrepreneurs might want to forgo building comprehensive infrastructures—such as with sales forces, marketing departments, and data centers. This may mean joining with a larger operator or even seeking out a strategic investment (BusinessWeek.com, 7/2/08).

Consider Gary Galloway. Back in 2003, he saw a large, untapped niche in the freight market for hospitals. He analyzed whether to build the service from scratch or find an existing company to work with. In the end, he decided to join forces with FDSI, a veteran operator in the space. That decision meant Galloway could get to market more quickly and at a lower cost. In fact, the operation is now growing at a hefty 50%-plus per year and is profitable.

The irony is he has received several offers for funding, now that he doesn't need it—which is always the best position to be in for any market environment.